Charlie and the Money Factory

The 80/20 Rule (Pareto's Principle) suggests that 20% of your ideas will produce 80% of your investment returns. Actually, there is an argument that says that 20% of your ideas produces 120% of your returns, and the other 80% cost you money.

Assuming that you can evaluate businesses, your best ideas (the 20%) are a money factory. They will multiply your wealth over and over again. Why would you put money in something else, if you can put it to work in your best ideas?

Well, my obsession with focus investing is well known but why take my word for it, when you can get it straight from one of its most successful practitioners, Charles Munger, Vice-Chairman of Berkshire Hathaway?

In the Question and Answer portion of the 2006 Berkshire Annual Meeting, (read the notes here), the following question came up:

If you were starting with $1 Million today, what strategy would you follow?

And Munger's response:

CM: Finding a single investment that will return 20% per year for 40 years tends to happen only in dreamland. In the real world, you uncover an opportunity, then you compare other opportunities with that. And you only invest in the most attractive opportunities. It’s all about opportunity cost. The game hasn’t changed at all. That’s why modern portfolio theory is so asinine.

If Warren were starting today, he’d put together a concentrated portfolio. Your 1 or 2 best ideas are way better than the rest. So when you act, you’re thinking about how the alternatives compare to your best idea. But you don’t want to own your 10^th-best idea when you can use that cash to invest in your best idea.

Focus on your best ideas. They will mint money for you.